What quantitative easing means for annuities

Anyone using their pension fund to buy an income for retirement stands to get a lot less for their money

The Bank of England’s decision to go ahead with more quantitative easing is bad news for anyone approaching retirement, as it means already tumbling annuity rates are set to fall further – so anyone using their pension fund to buy an income for retirement stands to get less for their money.

What is an annuity?

An annuity is a contract bought from an insurance company which offers to pay an income each year. Unless you have a final salary pension, where you will be paid an amount of your earnings every year after you retire, you will reach retirement with a pension fund that you need to use to provide you with such an income.

Although you can make withdrawals from that fund to pay for your living costs, most retirees will want a guaranteed income for the rest of their life, and will use an annuity to provide one.

What is the annuity rate?

This is how much the insurer will offer you as an income. In January 2012 the average annuity rate stood at 5.6%, according to moneyfacts.co.uk. This means if you used a pension fund of £100,000 to buy an annuity you would have been offered a pay out of £5,600 a year on average. A few years ago you would have received much more.

How much more?

Figures from pensions provider Hargreaves Lansdown show annuity rates have plummeted since July 2008. Back then a 65-year-old man with £100,000 to invest could have bought an annuity that would pay him £7,855 a year for the rest of his life.

Why have rates fallen?

Annuity rates are related to life expectancy: if an insurer thinks it will be paying you an income for 30 years after retiring it isn’t going to commit to paying as much each year as it would if it thought you’d only be around for 20 years. As people live longer, annuity rates fall. They are also related to gilt yields, which are the returns on government bonds.

And what does this have to do with quantitative easing?

The extra money printed by the Bank of England will be used to buy gilts, which will push up their prices. This means the return on them – the yield – will fall as a percentage of the price. According to Hargreaves Lansdown: “All other things being equal, lower long-term yields from gilts and corporate bonds will feed through into lower annuity rates.”

The last round of quantitative easing in March 2009 conincided with a drop in gilt yields and a fall in annuity rates. Hargreaves Lansdown’s figures show that the top rate for a 65-year-old male’s level annuity dropped fairly immediately from 7.214% on 5 March to 7.093% on 12 March, then to 7.043% on 26 March. In cash terms, income from a £100,000 fund over that time fell from £7,214 to £7,093, then to £7,043.

Gilt yields did bounce back before being pushed down again as the European debt crisis took hold. Investors have also moved into UK government bonds seeing it as a safe haven, again pushing up prices as a result.

How many people will be affected by falling rates?

In 2012 as many as 806,000 people could reach retirement age and start searching for an annuity, which is almost double the usual number, says Malcolm McLean, a consultant at Barnett Waddingham. This is a result of the baby boomers reaching pension age. McLean says the amount people get for their money could fall quickly: “When bad news comes they are pretty quick at adjusting rates downwards.”

So should people wait to buy an annuity?

That’s a high risk strategy. “Quantitative may have an affect, but the long-term trend is downward because of longevity,” McLean says. “The situation is going to get worse before it gets better.”

Tom McPhail, head of pensions research at Hargreaves Lansdown, agrees: “If you are planning to buy an annuity this year then it may well make sense to get on with it, as all the immediate pressure on rates is downward. In the longer term we may see rates recover, but there is no telling by how much or how long we might have to wait.”

Is there any way to improve the rate I get?

Even if you are a victim of timing you might be able to get a better rate than you first realise by shopping around for the best type of annuity and the best deal, rather than buying one automatically from your pension provider.

McLean cites one example of a retiree who was offered £5,000 a year by one provider and £5,800 by another – maybe not that much each year, but multiply it over the whole of the contract and it makes quite a lot of difference.

There are also different types of annuity: some that pay a level income for the rest of your life; some that raise the payout in line with inflation each year; and some that pay more if you have an illness and short life expectancy. Getting the right one for your circumstances could help you increase how much you receive.

Is that all the bad news?

Not according to the campaign group Save our Savers. It predicts the latest round of quantitative easing will keep interest rates down and “stoke up inflation”, which will erode interest being paid on people’s savings. And Howard Archer, chief UK economist at IHS Global Insight, says interest rates “remain highly unlikely to move from the current level of 0.5% for many, many months to come”.